What is energy price cap? Ofgem limit on UK bills explained, current level, will it still rise in October

The Ofgem price cap has been superseded by the Liz Truss government’s energy price guarantee

The UK has been embroiled in economic and political chaos since Chancellor Kwasi Kwarteng’s mini budget. The pound has tumbled in value against the dollar, while the Bank of England has been forced to stabilise the UK economy by buying up government debt.

But this upheaval has distracted from a major energy bills announcement that is set to come into effect from 1 October - Liz Truss’s energy price guarantee. This policy has been replicated in business form too.

It is a policy that had been welcomed by some as a useful intervention on the cost of living crisis, although its benefits have been wiped out somewhat by the huge hikes in interest rates experts think the Bank of England will have to introduce to bring down inflation.

What it does mean is that consumers will not be exposed to the massive energy bill hikes they would have faced if the Ofgem energy price cap had gone ahead as planned in October. But what is Ofgem - and is it still operating a price cap?

Ofgem’s energy price cap has risen markedly over the last 12 months (image: Getty Images)

What is the Ofgem energy price cap?

Ofgem - or the Office of Gas and Electricity Markets - is the UK’s energy regulator. Independent of government, it says it works to keep energy prices as low as possible, protect consumers and drive the UK towards its net-zero target.

Part of its role is to set a cap on what suppliers can charge people who are on default - i.e. standard variable - tariffs for a unit of energy, so as to stop them from being ripped off. This includes consumers who have prepayment meters.

The war in Ukraine has thrown Russian gas supplies into doubt (image: Getty Images)

These variable tariffs are usually more expensive than fixed-rate ones and tended to be followed by the UK’s poorest and most vulnerable households - until 2022 at least.

You are likely to be put on one if you’ve never switched supplier, your fixed rate term has ended, your supplier has gone bust, or you’ve moved house.

Given consumers have been advised to avoid fixing their energy bills or switching suppliers for the last nine months, millions of UK households are now on variable tariffs.

When you look at your energy bill, the price cap governs the maximum standing charge and price per kWh of gas and electricity your supplier can charge you.

The energy price cap has been forecast to hit £2,599 in October (image: Getty Images)

So, what you’re billed will almost certainly be above the price cap because it doesn’t determine the maximum you will have to pay for your energy usage. A typical household’s bill will sit around 55% above the price cap. A fact that is also true of Liz Truss’s energy price freeze that is set to come into effect from 1 October and will last two years.

How is the energy price cap calculated?

Ofgem determines its energy price cap by calculating how much it would cost a typical energy supplier to supply an average home. It does this by analysing several factors that impact our energy bills, as well as usage and market data over a review period.

The UK imports around half of its gas requirements (image: Getty Images)

These include:

  • Wholesale gas and electricity costs (i.e. what it costs suppliers to buy energy)
  • Network costs (e.g. what it costs suppliers to maintain energy infrastructure, like pipes and wires)
  • Social and environmental obligations (for example, the cost of adhering to government climate policies, including green levies)
  • Supplier operating costs and margin (roughly 2% of the average bill under the price cap)
  • Headroom allowance (an amount that helps suppliers manage unexpected costs, thus theoretically allowing them to offer competitive deals)
  • Taxes, like VAT
(graphic: Mark Hall/NationalWorld)

The factor that’s driven the major increase to the price cap has been wholesale costs. These have more than doubled, rising 131% from an average of £1,077 for the summer 2022 cap to £2,491 from October.

Wholesale costs will now be covered by the Liz Truss government as part of the energy price guarantee.

As well as wholesale costs, the cap has been pushed up because of how much it cost to move millions of consumers to new suppliers when dozens of energy firms collapsed in autumn 2021 - adding roughly £61 to the cap.

Ofgem has also said network maintenance costs have gone up - a likely consequence of the UK’s supply chain woes - while policy costs, like the rise in the warm home discount rebate, have risen.

(graphic: Mark Hall/NationalWorld)

How is the energy price cap changing?

Ofgem had planned to introduce a quarterly price cap for the next 12 months. When it announced the change, Ofgem said it would help “provide the stability needed in the energy market”.

However, this has now been rendered redundant by the energy price guarantee, which will set the maximum suppliers can charge consumers for units of electricity at what will work out as an average of £2,500 a year until 2024.

The energy price cap covers what rate a supplier can charge you at, rather than the maximum they can charge you in a bill (image: AFP/Getty Images)

Ofgem has said Russia’s actions in Ukraine had led to volatility in the global energy market experienced last winter lasting “much longer, with much higher prices for both gas and electricity than ever before”.

Ofgem chief executive Jonathan Brearley said: “I know this situation is deeply worrying for many people. As a result of Russia’s actions, the volatility in the energy markets we experienced last winter has lasted much longer, with much higher prices than ever before.

High global demand means the world’s gas supplies are in lower supply than usual (image: Getty Images)

“And that means the cost of supplying electricity and gas to homes has increased considerably. The trade-offs we need to make on behalf of consumers are extremely difficult and there are simply no easy answers right now.”

The price cap’s existence is legislated to run until 2023, but the government has indicated it could be extended.

What is new energy price cap?

The Ofgem price cap had been due to rise 80% from £1,971 to £3,549 on 1 October for people on variable tariffs who pay via monthly direct debit. For those with prepayment meters it was set to increase from £2,017 to £3,608 because Ofgem says it costs suppliers more to process these payments than monthly direct debits.

Cornwall Insight - a market analyst that accurately predicted the price cap rises - had an April 2023 forecast 86% above the October cap at £6,616.

But now the government’s intervention means electricity unit charges will be capped at £0.34 per kWh, with a daily standing charge of £0. 46. For gas, the cap is £0.10 per kWh with a daily standing charge of £0. 28.

Russia has threatened to turn the taps off to the west (image: AFP/Getty Images)

While this cap means charges will not rise by the huge amount that Ofgem had been set to implement before Liz Truss became leader, your energy bills will still depend on your usage. So, £2,500 is not the maximum amount you will be charged.

Given the Russia-Ukraine war and the subsequent sanctions against Vladimir Putin’s regime, as well as Moscow’s own threats to cut the West off from its energy, the wholesale price for energy is soaring. This is because all of these things throw into question supplies from Russia, which is the world’s second-biggest producer of natural gas.

Post-Covid demand from major economies like China, which has already been responsible for much of the global wholesale price increase, could mean there is even less gas to go around.

Markets are raising prices because they are factoring in that demand may have to be met by a smaller pool of supply in the coming months. While UK energy bills are now locked in for two years, supply might still be an issue for the UK.

Does the energy price cap have a future?

MPs who sit on the Business, Energy and Industrial Strategy committee described the price cap as out-of-date and urged the government to scrap it in a report published in July. They said it should be replaced with a discounted social tariff for the most vulnerable households.

“We were told by a number of witnesses, ‘if you think things are bad now, you’ve not seen anything yet’,” committee chair Darren Jones said.

“This winter is going to be extremely difficult for family finances and it’s therefore critical that public funds are better targeted to those who need it the most.”

Cornwall Insight has also said the cap “is not working for consumers, suppliers or the economy”. With Liz Truss’s energy support packagee, it now means the price cap may not have a future.

The BEIS committee report also criticised Ofgem and the government for their response to the energy bills crisis.

It accused the energy regulator of “incompetence over many years”, which allowed poorly run and backed companies to start energy companies.

Ofgem has been criticised by MPs for how it has run the UK energy market (image: Getty Images)

Ofgem said the massive gas price spike “would have resulted in market exits under almost any regulatory system”, but admitted its previous regime was “not robust enough” and this contributed to some suppliers failing.

Meanwhile, the Boris Johnson government was criticised by MPs for allowing the energy bills crisis to ‘race ahead’ of it.